Cutting rates is Fed's next gambit

WASHINGTON — As the economic wreckage piles dangerously higher, the Federal Reserve is prepared to ratchet down interest rates this week — perhaps to their lowest point in more than four years — with the hope of relieving some of the pain felt by many Americans.

The convergence of a housing collapse and a lockup in lending has created the worst financial crisis in more than a half-century. Alan Greenspan, who ran the Fed for 181/2 years, called it a "once-in-a century credit tsunami," and conceded that he made mistakes.

The economic problems have been feeding on each other, and Fed Chairman Ben Bernanke and his colleagues haven't been able to break the cycle, despite hefty rate reductions and a flurry of unprecedented steps aimed at getting credit flowing more freely again.

Bernanke says he'll use all tools to battle the crisis. To that end, Fed policymakers are widely expected to lower the central bank's key interest rate at the conclusion of a two-day meeting Wednesday — their last session before the November elections.

Investors and some economists predict the central bank will drop the rate by half a percentage point to 1 percent. If that happens, it would mark the lowest rate since the summer of 2004. Others, however, think the rate will be cut less, by a quarter-point, to 1.25 percent.

In turn, rates on home equity, certain credit cards and other floating-rate loans tied to commercial banks' prime rate should drop by a corresponding amount. A half-point reduction would put the prime rate at 4 percent; a quarter-point cut would drop the rate to 4.25 percent. Either way, the prime rate would be the lowest in more than four years.

With a recession seen as inevitable, if not under way, any Fed rate cut would be aimed at cushioning the fallout.

Vanishing jobs and shrinking paychecks have forced consumers to cut back sharply. Millions of ordinary Americans have watched their 401(k)s and other nest eggs shrink and the value of their homes drop. In turn, businesses have cut back on hiring and other investments as customers hunker down and credit problems make it harder and more costly to get financing.

Earlier this month, the Fed and other central banks joined together to slash rates, the first coordinated move of that kind in the Fed's history. That dropped the Fed's key rate down to 1.5 percent and marked an about-face in policy. Fearing inflation, the Fed in June halted an aggressive rate-cutting campaign that started in September 2007, aimed at shoring up the economy.

Richard Yamarone, economist at Argus Research, said a new rate cut by the Fed "would be a good-faith psychological move." But he and others doubt that another reduction will entice people — many buried under piles of debt — to ramp up spending. It might help a little, they said.

Consumer spending — which accounts for the single-biggest chunk of overall economic activity — probably fell in the July-to-September quarter. That would mark the first quarterly drop since late 1991, when the country was coming out of a recession, economists said.

Given that, many predict the national economy contracted in the third quarter. The government releases the report on gross domestic product on Thursday.

GDP measures the value of all goods and services produced within the United States and is the broadest barometer of the country's economic health. Many think the economy will continue to contract through this year and into next year. All that would more than meet a classic definition of recession — two straight quarters of shrinking GDP.

Bernanke has repeatedly warned that the country's economic weakness could last for some time — even if the government's unprecedented $700-billion financial bailout package and other steps do succeed in getting financial and credit markets to operate more normally.

Many expect the unemployment rate — now at 6.1 percent — to hit 7.5 percent or higher by next year. Employers have cut jobs each month this year. In all, 760,000 jobs have disappeared.

Whether Democrat Barack Obama or Republican John McCain wins the election, the next president will inherit a troubled economy and a record-high budget deficit that could cramp his domestic agenda.

FAST FACTS

Why a rate cut?

The Fed hopes that lower rates will spur people and businesses to spend again, helping to brace the wobbly economy.

>>fast facts

Why a rate cut?

The Fed hopes that lower rates will spur people and businesses to spend again, helping to brace the wobbly economy.